There are two types of legal questions – those that are solved by bright-line rules created through code or court precedent. And those that linger without set-in stone standards, just waiting for a plaintiff’s attorney to take up the case and head to the courthouse hoping for a favorable ruling and possibly establishing precedent along the way.
In my experience, the mortgage space as of late is dominated by the latter.
It should come as no surprise that financial institutions – or firms that take on default risk – prefer the former legal situation. Certainty is better than lack of clarity when establishing your underwriting guidelines, especially with the industry spending millions of dollars to get the compliance and the technology right after the release of the qualified mortgage rule.
So why is it so difficult after QM's release to get a clear standard in play and a straight answer on what is expected of lenders? Perhaps, regulators themselves are having trouble setting the message straight themselves.
Members of the financial services industry paused this past month when Richard Cordray, director of the CFPB, shared the following message with credit unions during a speech:
"I know that complying with our new regulations is a worry for many of you. So allow me to make a few points clear. First, the criteria for Qualified Mortgages are intended to describe only the least risky loans that can be offered to consumers. But plenty of responsible lending remains available outside of the Qualified Mortgage space, and we encourage you to continue to offer mortgages to those borrowers you can evaluate as posing reasonable credit risk. Those that lend responsibly – like credit unions – have no reason to fear the Ability-to-Repay rule.”
What? Lending outside QM? Who would do that, the industry is asking itself?
Are banking attorneys choking on their coffees yet? After all, they greeted the QM rule like the last hot dog at the baseball game because their clients have been collectively waiting for them to decipher the rules so they can lend again and do so safely within the safety zone of CFPB rules.
To be fair, Cordray is stating the obvious: Credit unions were known to assess default risk consistently before the financial crisis, but even they have to look at litigation tail-risk because of the uncertain fate of most mortgages. Even good borrowers can land in default. What happens if after doing so, they find a good attorney and that attorney finds the credit union outside of QM? Do the credit unions get a break in that situation? And is it wise on the back of the news that some credit unions are, in fact, loosening lending criteria?
As previously explained the qualified mortgage rule comes with two legal standards: a safe-harbor QM and the rebuttable presumption qualified mortgage rule.
Both of which are explained here.
The safe harbor was what was desired by the industry since it makes it easier to know what boxes to check during the underwriting process to stave off future litigation risk over ability-to-repay. The rebuttable presumption leaves perhaps more tail-end risk, but it’s better than nothing.
But Cordray caught the industry way off-guard when he said: "plenty of responsible lending remains available outside of the qualified mortgage space" and he encouraged credit unions to use their own judgment in making the call.
But the problem is what happens when the inevitable occurs? Someone defaults, and it could be a default for any unforeseen reason. If the credit union is not inside the QM, then the credit union – whether favored or not – seems to have viable tail-end litigation risk unless there is some specific exemption they qualify for.
The only conclusion to draw from the Cordray speech is this: No clear message has been communicated to the industry on what lending should look like. Mostly because lending has always been somewhat of a science and an art thrown together. Today's good borrower can easily turn into a risk later on.
Certainly you can be more careful or less careful, but the lines get blurred when someone says there's a rule, and then adds you don't necessarily have to follow it.
There are still too many unspoken demands and exceptions, making today’s space no more safe or clear than it was in the early 2000s.